How did Texas dodge the housing meltdown? By restricting cash-out refinancing, argues Alyssa Katz, author of the excellent book "Our Lot: How Real Estate Came to Own Us."
Katz's theory has a lot of merit. I'm not fully convinced, though, because Katz ignores that Texas had a cataclysmic housing bust in the middle of the 1980s.
In her essay in The Big Money, Katz notes that Texas has plenty of room to allow sprawl, just as Arizona and Nevada have. But the mortgage delinquency and foreclosure rates in Texas are far lower than those of Arizona and Nevada.
The consumer spending boom of the early and mid 2000s was fueled by cash-out refinancing and home equity lending. An exemplar is a guy who used to live on my block. He bought his house in 1999 for $123,000, with a conforming mortgage. He got his last cash-out refi in August 2005 -- a 2/28 subprime loan for $298,300.
Dude bought a tricked-out Touareg and a Harley. According to court documents, he ended up paying child support to a woman he wasn't married to. His wife divorced him, and my former neighbor was sued by his attorney for nonpayment of fees. He sold the Harley to a neighbor and Wells Fargo foreclosed on the house in February 2007, less than 18 months after he got the loan.
In six years, he used his home as an ATM and extracted $175,300 cash.
For a while, my neighbor lived well, and salesmen at VW and Harley dealerships profited, and whoever else he threw money at. But problems were created by his ability to borrow 100 percent of the home's value. The banks, eager to lend as much money as possible, allowed appraisals to become inflated. All over my neighborhood and in much of the country, the combination of subprime lending, 100 percent refinancing, and inflated appraisals led to a wave of foreclosures that hasn't yet crested.
What if my neighbor had been restricted from cashing out more than 80 percent of the home's value, as if he were in Texas? Near the top of the market, when his home's value was appraised at about $300,000, he wouldn't have been able to refinance for more than $240,000.
Would this have prevented a housing bust? Maybe not. Consider this: My former neighbor's house sold for $185,000 last August in a foreclosure sale. Even with an 80 percent cash-out limit, the previous owner would have been underwater by more than $50,000 last year.
But I'm assuming that home values would have climbed that far with the 80 percent cap in place. That's a debatable assumption. Katz writes:
The home-equity restrictions have not only helped keep cash-out refinances a rare breed in Texas; other risky mortgages were scarce there, too. The home-equity borrowing restrictions helped keep home prices from overinflating, and homebuyers therefore didn’t need to turn to exotic mortgages with features like 2/28 ARMs, interest-only payments, or negative amortization in order to purchase a home. Even when they did, Texas law requires these risky features to be clearly disclosed. Fewer than 20 percent of Texas subprime mortgages included any of them.
That's not to say that Texas borrowers didn’t get into bubble trouble. Plenty bought overpriced houses, which is why 1 in 8 Texans now owe more than their home is worth. And it was easy enough for lenders to get around the home-equity borrowing limits by using creative appraisals that pretend a home is worth more than it really is. But the casualties are orders of magnitude less than they would have been without the home-equity limits.
But Katz misses something, I believe. She misses Texas' 15-year housing bust. In a study released last year (PDF file), the Federal Housing Finance Agency says Texas house prices peaked at the beginning of 1982 and declined steadily until the beginning of 1997. Prices slid for 15 years. "Texas' real estate prices have yet to fully recover and now are roughly 15 percent below their prior peak," says FHFA's report, issued last June.
Read that again. Home prices in Texas peaked in 1982, and 27 years later, prices were still 15 percent below that 1982 peak. Those are inflation-adjusted prices, not nominal prices.
That leaves me with two thoughts. First, that maybe Texas home prices behaved differently in the 2000s than prices in Arizona and Nevada because Texas was in a different quadrant of the housing cycle. Second, that it might be decades until prices in Arizona, California, Florida and Nevada fully recover, if they follow the example of Texas.